A Reader’s Question on Valuation Ratios. This sheet may be good as a guide to go through an annual report, but none of those ratios means anything without context. Is growth good? It depends. Only profitable growth within a franchise. How about asset turnover? For some companies like Costco asset turnover is critical but not for Boeing (gross margin). Why not take those ratios and work through the financials of these trucking companies. Which company is doing the best? Why? Follow the money! Those ratios may help you structure the information you pull out from the financials. But first focus on how does the company provide a service to its customers and then trace the financial effects back to your returns as an investor.

On August 24, 1921, the low point of the Dow, many stock prices translated into multiples on 1923 earnings of less than five times. That held true of the steel companies but also of the kind of consumer-products companies that had enjoyed a relatively prosperous depression. Thus, Coca-Cola, at $19 a share—500,000 shares were outstanding, providing a stock market capitalization of all of $9.5 million—was valued at what would prove 1.7 times 1922 earnings and 2.5 times 1923 earnings; the shares provided a dividend yield of 5.26%. Gillette Safety Razor Company, which was selling as many razors and blades in 1921 as it had in 1920, was quoted at a little more than five times forward earnings and yielded 9.23 percent. Radio Corporation of America, not yet revealed as one of the great growth stocks of the 1920s, could be purchased in the market for about as much as the company earned in 1923: $1.50 a share.

As a matter of course on Wall Street, bargains hold no appeal at the bottom of the market. In August 1921, stock prices had been sliding for almost two years. At such junctures, the memory of losing money is usually more vivid than the imagined prospect of making it.

It didn’t take much imagination to recognize the value of F.W. Woolworth Company, the five-and-dime chain merchandiser that was finishing its tenth year as a fused corporate unit. Frank W. Woolworth himself, founder and builder of the gothic corporate headquarters tower at 233 Broadway in lower Manhattan, had died in 1919, but his successors had distinguished themselves in the depression. They had stopped buying any but essential merchandise after the break in whole sale price in June 1920, while customers, happily, had kept right on buying. Now 1921 sales were on track to surpass the total for 1920. While other chain stores had raised prices, Woolworth hewed to the letter of its five-and dime appellation (15; cents was the top ticket west of the Mississippi). And how was this exemplar of deflation-era merchandising—about to close its year without bank debt and with no mis-priced inventory—valued in the stock market on August 24, 1921? At a price of $105 a share, or 3.7 times imminent 1922 earnings and 3.3 times what would turn out to be 1923 earnings. The stock yielded 7.62 percent.

F. A. Hayek: “The curious task of economics is to demonstrate to men how little they really know about they imagine they can design.”

As a preview to understand how the law of demand and supply works seeTrading Places in the PitsHint: Are there more buyers than sellers?

Thus you can explain the fallacy of Eric Sprott’s sentiment that demand is overwhelming supply:

We see almost 60 tons a week being delivered on the Shanghai Gold Exchange. Well, you start annualizing 60 tons a week you’re talking 3,000 tons a year now. We saw 94 tons of gold go into India in September. We saw the Russian Central Bank buy 37 tons of gold in September. I mean I could come up with numbers that might suggest that we’ve got 400 tons a week of demand. And we only got 230 tons a week of mine supply. And I’ve only gotten to three data points. I haven’t even gone to the rest of the world.

We’ve now created a situation unfortunately in the market where between high frequency trading and algorithms and interference by the planers they can make things happen that looks like everything is OK. And it’s the “OK” part where I think we can really relate to gold not being allowed to go up. Because that’s the canary in the coal mine. If gold was above $2,000 we’d all be wondering: What the hell is going on here? And so they haven’t allowed it to happen.

But by suppressing the price – and one of the great things about a price of $1,100/oz is that you can buy a lot of gold at $1,100 versus $1,900 — you can buy almost 50%-60% more gold than you could three years ago with the same amount of money. And you can buy 3x the silver. With the same amount of money!

Of course, demand must equal supply or supply equal demand at a CLEARING PRICE. Go to pages 137 to 138 to understand Reservation Demand (critical in understanding a high stock to flow good like gold) Man Economy and State by Rothbard

If you don’t understand price moves against you, then scream manipulation on price declines. But where was the “manipulation” from 2000 to 2011 while gold rose in price vs. the U.S. Dollar by 1,600 dollars! You are a fool either way. You trade in a rigged market or you complain that you are buying a good that is artificially depressed. You are subsidized to buy gold at “below” market (read manipulated) prices yet you complain.

The amount that a seller will withhold on the market is termed their reservation demand. This is not, like the demand for a a good in exchange, this is a demand to hold stock. Thus, the concept of a “demand to hold a stock of goods” will always include both demand factors, it will include the demand for the good in exchange by nonpossessors, plus the demand to hold the stock by the possessors.

I strongly suggest that if you wish to improve as an investor that you read Rothbard’s book along with the free study guide. The implication that demand is overwhelming supply with a falling price is absurd! Yet, Goldbugs howl incessantly that the price is being suppressed since demand is “overwhelming supply.” Nonsense, everything equals AT A PRICE.

Did you view the video of trading places above? Where was Louis’ Reservation Demand? SELL 200 APRIL ORANGE JUICE AT 142!

Gold wasn’t always in the dumps. It rose right along with equities, indeed outperformed equities, from the 2009 Great Recession bottom – when central banks the world over first began implementing their unconventional monetary policies – straight through to its September 2011 top. The reason we think it did is quite simple. Coming out of the Great Recession, central bank credibility – their ability to “pull us out” of the Recession – was being severely questioned by investors. Thus, a good portion of investor money found its way into gold. That changed in 2011. Underwritten by these same central bank easy money policies, the as yet unresolved malinvestments of the Housing Bubble turn Credit Bust turn Great Recession, which were in the process of a healthy liquidation, were short circuited, while new, yet to be revealed malinvestments (we think the largest being anything in and around financial engineering) were starting to bear fruit. The belief took hold that the heroic policies of these central banks were finally working, finally restoring long term vitality to the economy. Gold then sunk while equities marched ever higher. So here we are…

The price of gold may be rising, but gold mining stocks are getting hammeredtoday. And do you know why?

They are still stocks. (What does THAT mean?)

On the heels of yesterday’s late-day price surge, the Market Vectors Gold Miners ETF (GDX), of fell more than 4.5% amid a broader market selloff that sent the Dow dropping more than 300 points and the S&P 500 declining almost 2%.

The dovish minutes from the Federal Reserve’s September policy meeting have gold bugs buzzing. The precious metal touched a two-week high today, amid easing concerns that the Fed is near to raising interest rates, reviving gold as an inflation hedge.

Gold prices rallied to $1,234 a troy ounce, their highest level since Sept. 23, a day after minutes from the Fed’s September policy meeting revealed officials were worried weaker growth in Asia and Europe could curtail U.S. exports. The central bank also highlighted a stronger dollar as a barrier to U.S. inflation climbing toward the Fed’s 2% target, stoking hopes for a sustained period of low interest rates.

The most actively traded contract, for December delivery, was ended the day at $1,225.10 a troy ounce on the Comex division of the New York Mercantile Exchange, up $19.10, or 1.59% after earlier today climbing as high as $1,380.

But while worries regarding a weak economy can lift gold prices they can squeeze gold mining companies. GDX has plunged more than 60% over the past two years with the likes of Barrick Gold (ABX) falling more than 65% during that same time span and Newmont Mining (NEM) falling 59%.

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The above is an article from an “elite” financial publication (Barrons) where the theme is that miners are being hurt/squeezed because they are stocks. I ask my readers how are miners hurt LONG-TERM (the next decade) if the REAL price of gold is rising? Sure miners may have been sold today due to leveraged investors selling to go into cash, but how does that “squeeze” the mining business if gold is risng RELATIVE to input costs like crude oil and commodities? Mining is a spread business. You make money on the spread between input costs and output revenues. Never take what you read on face value.

Miners realtive to gold in the chart above.

Four Boom and Bust Cycles and the Implications for today’s Cycle (Microdocumentary)

This microdocumentary video examines in detail 4 major booms in the last 100 years and explains how monetary policy and interest rate manipulation has led to the inevitable bust:

Though, I like miners more, but now is a good time to pick up tangible money at a discount. Pay 94 cents and get a dollar of gold and silver today–I will take it. SOLD! Miners make money on the arbitrage between their input costs and output prices. You don’t need a rising nominal gold price; you need a rising REAL gold price.

Now is the time for me to post on Yamana (by this weekend, I pray) because it is at a price $7.33 that I have purchased in the past and it may be a reasonable choice for a BASKET of miners.

Also, you want to see analysts pile-on negatively AFTER price has fully dicounted the news. I am not being contrarian or cynical, it is just how markets work–they DISCOUNT.

Yamana Gold (AUY-1.2%) is lower after Morgan Stanley, Credit Suisse and Raymond James cut their price targets on the stock to $10.70, $10.50, and $10, respectively.

In the case of Morgan Stanley, the lower target still implies upside of more than 40%; AUY has said the Pilar mine in Brazil has shown improvements with output increasing M/M, but the ramp up is tracking modestly below expectations, thus the firm’s tempered outlook.

An update on Canadian Malartic and meeting quarterly expectations are potential catalysts expected over the next 6-8 weeks.

http://vimeo.com/102086456 Interview with Charles W. Calomiris who wrote Fragile by Design, the Political Origins of Banking Crises & Scarce Credit

(Csinvesting: This is an important, well-written book to understand why another banking crisis is inevitable plus you receive a history of U.S. and foreign banking systems.

Why are banking systems unstable in so many countries–but not in others? The United States has had twelve systemic banking crises since 1840, while Canada has had none. The banking systems of Mexico and Brazil have not only been crisis prone but have provided miniscule amounts of credit to business enterprises and households. Analyzing the political and banking history of the United Kingdom, the United States, Canada, Mexico, and Brazil through several centuries,Fragile by Design demonstrates that chronic banking crises and scarce credit are not accidents due to unforeseen circumstances. Rather, these fluctuations result from the complex bargains made between politicians, bankers, bank shareholders, depositors, debtors, and taxpayers. The well-being of banking systems depends on the abilities of political institutions to balance and limit how coalitions of these various groups influence government regulations.

Fragile by Design is a revealing exploration of the ways that politics inevitably intrudes into bank regulation. Charles Calomiris and Stephen Haber combine political history and economics to examine how coalitions of politicians, bankers, and other interest groups form, why some endure while others are undermined, and how they generate policies that determine who gets to be a banker, who has access to credit, and who pays for bank bailouts and rescues.

Charles W. Calomiris is the Henry Kaufman Professor of Financial Institutions at Columbia Business School and a professor at Columbia’s School of International and Public Affairs. His many books include U.S. Bank Deregulation in Historical Perspective. Stephen H. Haber is the A. A. and Jeanne Welch Milligan Professor in the School of Humanities and Sciences and the Peter and Helen Bing Senior Fellow at the Hoover Institution at Stanford University. His many books include The Politics of Property Rights.

I use this blog sometimes as a bulletin board so I can look back in time over events.

Yes, this is an equity bubble:

At present, the major risk to economic stability is not that the stock market is strenuously overvalued, but that so much low-quality debt has been issued, and so many of the assets that support that debt are based on either equities, or corporate profits that rely on record profit margins to be sustained permanently. In short, equity losses are just losses, even if prices fall in half. But credit strains can produce a chain of bankruptcies when the holders are each highly leveraged. That risk has not been removed from the economy by recent Fed policies. If anything, it is being amplified by the day as the volume of low quality credit issuance has again spun out of control. http://www.hussmanfunds.com/wmc/wmc140728.htm

What “Bubble?” Crazy Chicken (Loco–the next Chipolte?)

Real Estate

Here is a simple exercise that we all should do individually to help us with real estate related decisions:

1. Extend the above chart for the next 5 years. What do you think it is going to look like?

2. Give this some thought. Do you think real estate prices should be inversely proportional to the decline in mortgage rates?

3. Use your own real estate purchase as an example. Mark the date of purchase and plot its price movements over the above chart. If you think falling mortgage rates should stimulate prices, is that true in your case?

In conclusion, does Fed policy really have anything to do with the real estate market? I believe Fed policies have been misguided for far too long, artificially propping up prices that should be much lower.

If one wants to identify bubbles, one must perforce study monetary conditions. The comparison of historical data on valuations and other ancillary factors can only take one so far. The problem is that in times of strongly inflationary policy, the economy’s price structure becomes thoroughly distorted, and that therefore a great many “data” can no longer be regarded as reliable. An added complication is that we e.g. cannot know in advance if the effects of the inflationary policy on prices will broaden out or not. Should “inflation expectations” (expectations regarding future CPI rates of change) rise markedly in the future, this would have a major impact on valuations, which would then begin to contract rather than continue to expand.

However, a bubble can easily burst even if this doesn’t happen. Ultimately the question is whether brisk money supply growth will be maintained and whether the economy’s real pool of funding is still large enough to allow for additional diversions of scarce resources into bubble activities. Most of the time, it the eventual slowdown of money supply growth that brings a bubble to its knees. http://www.acting-man.com/?p=32003#more-32003

Predicting is hard

A bullish call:

“Conditions for a hard economic landing — like slack in the labor market and weak balance sheets — are still largely absent.”

If the case for U.S. stocks is built on global growth and lower interest rates, other factors, too, suggest that the market is heading higher. For one, Washington is determined to avert a financial disaster, particularly in an election year….

Bull markets rarely end when the earnings yield on stocks — now around 6% — is higher than benchmark bond yields.

While some fear this year’s peak profit margins will wane, __________ says “margins will prove sticky at a high level” after years of cost-cutting. A 35% decline in leverage in the past five to seven years has made for healthier balance sheets, and continued stock buybacks are likely to keep boosting earnings per share.

Then there’s the market’s modest valuation. The S&P 500 trades today at just 15.6 times average estimated earnings — well below the average P/E of 18.6 times earnings during periods when inflation was at similarly muted levels in the past 57 years…

Stocks are “screamingly cheap relative to bonds.”

“The right time to get more aggressive [about the stock market] is closer to the end of the Fed’s easing cycle,”

“While the first half may look like death, second-half earnings will improve….

“The consumer is not dead!”

What’s more, the richest 20% of Americans drive 40% of the country’s consumer spending, and their outlays are less restrained by rising gasoline prices and higher mortgage rates. Dated Dec. 17, 2007

I think most investors have the wrong idea about what it means to be bullish or bearish about an asset class such as stocks. Being bullish or bearish is not an all or none decision. Believing that the US stock market is richly priced does not mean that all US stocks are richly priced. It just means that the market, taken as a whole, is priced at a level that involves an above average level of risk. That risk, as last year so amply demonstrated, may not be realized in the short run or even what some might consider the long run. But the risk still exists and investors should take it into account when allocating their assets.

Peter Bernstein, one of the greatest investors who ever lived, once said: Survival is the only road to riches. What that means to me is that, in a world where the future is unpredictable (that would be the one we live in), one must take into account the worst case scenario as an investor. What you shouldn’t do, as the quotes above prove, is take conditions as they exist today and assume they will continue into the future. Profit margins are always high when the economy is expanding and they always fall in a recession. You may not know when a recession will come but you know it will. Survival investing dictates that you take into account what happens to margins in a recession. Stock buybacks – at least since tax reform made them preferable – are always high when things are good and always disappear when the market needs them most.

You don’t have to know exactly how things will change just that they will. In any scenario with multiple potential outcomes you have to at least consider all the alternatives. No matter what you expect, you have to assign some probability to the opposite outcome. If you believe the economy will accelerate in the second half of the year, what are the consequences of being wrong? In a highly priced market, being wrong about future growth could prove quite costly. It is the consequences of being wrong that reveal your true risk level.

Epstein doesn’t seem to understand that the U.S. government doesn’t need to borrow what it creates. The U.S. government creates dollars. The U.S. government doesn’t need to borrow them to spend them. This seems so simple to me it’s hard to believe anyone would believe otherwise.

… There is an economist, Scott Fullwiler, who explained this in a post at the New Economic Perspectives blog site:

“A currency-issuing government under flexible exchange rates can’t have such crises, because it doesn’t need to borrow its money; interest rates on its debt are a monetary policy variable. The doomsayers have been at this for decades now, but have not explained why the U.S., U.K. and Japan ran continually large deficits starting in 2008 at low interest rates while Greece, Spain, Italy, etc., could not… At some point, one would think the ‘U.S. could become Greece’ argument would be widely recognized as fraudulent, but if you’re in the wrong paradigm, it’s difficult to accept even a simple explanation of why the paradigm is wrong.”

Hopefully, you can accept a simple explanation.

It’s true there are constraints. For example, there’s the debt ceiling. But this is a self-imposed restriction.

There is no reason why the U.S. should have a fiscal crisis of any sort. Such a crisis could only be self-imposed. So the real risk is that policymakers don’t understand how their own fiat currency works. The real risk is that they listen to the CBO.

.. If you don’t get the realities, then you invest foolishly. If you believe Epstein is right, then you’ll likely miss out on all kinds of great investment ideas because you’ll be afraid of a looming debt crisis. Instead, you’ll put your money in junky gold stocks — as if that will protect you!

Locals and foreigners alike pay US dollars for goods and services across Panama just as you would in Houston, Jacksonville, or Las Vegas.

This means that the country is subject to all the whims and consequences of US monetary policy; when the Fed conjures money out of thin air, the negative effects are quickly exported to Panama.

Yet while it suffers all of the downside of quantitative easing, Panama enjoys very little of the upside. Of the jobs that the Fed claims they have created by printing $3.7 trillion over the last few years, zero of those have ended up in Panama. Not to mention, the Panamanian government doesn’t have an endless supply of foreigners lining up to buy its debt.

So to get a true sense of US dollar inflation… and where it’s headed in the Land of the Free… one only need look at dollarized countries like Panama.

On February 16, 2010, I first gave a speech titled “Hyperinflation: A Statistical Inevitability” at a charity event in Dallas, Texas. In essence, the talk was a “warning” that unless the growth of the nominal debt versus nominal GDP changed to a more normal balance, the US would “eventually” suffer from hyperinflation.

Hyperinflation is a debt problem whose root cause is when a country’s level of debt rises to a level that when its economy goes into a deep recession (or depression) the country cannot borrow money or raise enough taxes to cover its expenditures, and therefore it is forced to print money to cover a greater percentage of its expenditures than the markets and investors think is sustainable. This concludes in the country’s inability to pay the interest on its debt, which progressively consumes its overall budget, causing the country to continue to print money to pay its ever increasing debts and interest thereon, which ultimately leads to a loss in confidence in its currency, ending with hyperinflation as the result.

Editor: Note the difference between inflation and hyperinflation (hyperinflation is NOT just an ultra-high rate of inflation) See links below.

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Where the U.S. Stands Today

My original speech was based on the 2010 Congressional Budget Office’s Budget and Economic Outlook Fiscal Years 2010-2020. At the time, total US debt was growing at an unsustainable rate of 11.90% compounded from 2006 -2010 (fiscal years) while gross GDP was growing at a nominal rate of 2.75%. Debt was increasing at 4.3 x’s higher than growth. Clearly, this was an unsustainable situation.

Further, the reason that I state hyperinflation will occur “within” the next 10 years has a logical basis. If one takes the position that the net debt will grow at 5% a year, total U.S. debt will be $27.324 trillion in 10 years (not including current off-balance sheet items or unfunded liabilities). As the CBO does not project total U.S. debt, only public debt, the $27.324 trillion figure is based on my projection.

Now, what will interest rates be in 10 years? The CBO says an average yield is 4.6% (CBO 2/13 Report page 5), but let’s assume it reverts to the mean for bills and bonds of the last 52 years, or from 1961, which was 6.01%. Assuming that spending increases 5.08% a year from 2014-2023 (CBO 2/13 Report page 3), they say annual spending will be $5.082 trillion in 2023 net of annual interest.

However, annual interest in 2023 on my projected $27.324 trillion total U.S. debt (using the historic average interest rate of 6.01%) will be $1.642 trillion, or 32% of projected 2023 annual spending without interest and 24% of projected 2023 annual spending with interest. Today, interest is 6% of the budget. Therefore, one has to ask the question, where does the approximately 20% difference come from? I believe U.S. bond holders will sell what they own, the U.S. dollar will decline, and the Fed will print money at a rate that will make today’s Fed look like they are Shaolin Monks.